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Capital markets and IPOs: to float or not to float

Gateley Legal

One of the biggest decisions a company can make is whether to go ‘public’ and ‘float’ its shares on the stock market. Being a public company is a requirement for flotation so a private company wishing to float will have to re-register as a public company, as well as satisfy various other criteria, before its shares can be admitted to a public market, such as those operated by the London Stock Exchange (LSE).

The process of a company floating its shares on a stock market is known as an initial public offering (IPO) and will involve a range of different parties, from investment banks which will assess the market’s appetite for the flotation, to lawyers which will provide advice on meeting regulations, carrying out due diligence and producing a prospectus or admission document. All of this will involve substantial time, money and effort which may be better used in running the day to day operations of the company.

So given the arduous nature of completing an IPO, why would a company ever look to go through it?

Advantages

Investor exit route

Listing a company’s shares gives financial institutions and the wider public the opportunity to own shares in the business. A large pool of potential investors will allow historic investors in the company, such as private equity funds, to realise their investment and capitalise on the increased liquidity of the shares. This was the case in 2007, where (Newcastle United fans look away now!) Mike Ashley earned over £900m by selling 43% of his shares in Sports Direct through the company’s IPO.

Access to equity

Admitting shares to a public market brings access to an alternative source of finance to which firms can turn for investment. Borrowing can expose a company to further debt and interest repayment obligations, but equity financing will allow a firm to raise capital in a relatively risk-free manner by issuing shares to investors. However, with current interest rates at near historic lows, firms may be persuaded to raise funds through borrowing rather than equity.

Raise profile and enhance perception

The increase in press coverage and analysts’ reports associated with going public should help to raise the company’s profile and because being a listed company brings added regulatory compliance and disclosure requirements, this can enhance the company’s overall status.

Disadvantages

Regulation

In addition to the time and cost involved in completing an IPO, further drawbacks include the need to comply with a range of complex legislation and regulations, which exist in order to protect members of the public who may choose to invest.

Market exposure

Floating a company will subject it to the whim of the market. Even where a company demonstrates strong financial results, if the general mood and outlook in the economy is downbeat, this will likely have a knock on effect on the market price of the company’s shares.

Loss of control

A key factor which may dissuade a board of a private company from completing an IPO is further loss of ownership; the company will become subject to wider shareholder scrutiny. This has been seen recently where proposed investors in Lyft’s multi-billion dollar IPO criticised a plan to introduce a share structure which would provide Lyft’s founders with twenty votes per share, with the remaining shareholders having one vote per share. Potential shareholders argued this was unfair as it would not adequately compensate them for their investment.

Which market?

Having considered the benefits and drawbacks of an IPO, a company must choose which market to float its shares on. In the United Kingdom, this will generally be a choice between the LSE’s Main Market and AIM.

Main Market

As the name suggests, this is the main market for companies which choose to list their shares in the UK. The largest 100 companies make up the FTSE 100, a popular index for analysing market conditions in the UK. The Main Market imposes onerous listing and continuing obligations on companies which float their shares but complying with these can help a company demonstrate a robust financial standing. This will reassure investors that the company is a good investment option, allowing it (in theory) to access more preferable terms on which to conduct its business with suppliers and customers. Companies must be of a certain size and have a trading history before they can list on the Main Market.

AIM

AIM, as the junior market, imposes less stringent listing and continuing obligations, and represents a more straightforward route to accessing capital. The majority of firms which opt for this market are smaller companies wishing to make shares public without having to comply with the additional burdens of the Main Market.

One advantage of AIM is that it allows a company to complete certain substantial transactions without having to obtain shareholder approval, which is a requirement for companies on the Main Market. This allows the board of an AIM company to retain a greater deal of control over key business decisions. The board of a Main Market company must seek the permission of shareholders on a much more regular basis.

Looking forward

Continued economic uncertainty surrounding Brexit (as ever!), as well as ongoing trade skirmishes between the US and China have resulted in a drop in admissions, from 95 IPOs in London in 2017 to 79 in 2018.

Given that the economy shows no sign of stabilising just yet, it is likely that 2019 will follow a similar course as boardrooms across the country wait to see how political and economic events play out.

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